Many articles in the legal and economic literature claim that a pure Haig-Simons income tax
cannot effectively tax investment income. This is because an investor can use leverage to gross
up her investments in risky assets such that the increased gain (or loss) exactly offsets any
income tax (or deduction) on the returns to risk-taking. This article argues, however, that
while it is possible for an investor to make such portfolio shifts, she almost certainly will not
because of the increased risk of doing so.

Central to any discussion of the effects of taxation on investment risk-taking is the meaning
of risk itself. The central claim of this article is that a better conception of investment risk is
the risk of loss and not merely the variance of returns. Applying this notion of risk—one
that is well supported in the finance literature but new to the taxation-and-risk literature—
to an investor’s portfolio choice question shows that an investor will not increase her
investment in risky assets by enough to offset the tax. As a result, there is an effective tax on
investment risk-taking under a normative income tax.